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Variance is a measure of volatility. Variance is calculated as the average squared deviation from the mean. The Capital Asset Pricing Model uses variance as a measure of investment risk. Investments with higher volatility (variance) have greater risk. CAPM postulates that the risk (variance) of an investment portfolio consists of both market risk and specific risks associated with each asset. While market risk is unavoidable, portfolio variance can be minimized and the risk associated with specific assets reduced if the investor owns a diversified mix of assets. Most financial advisors seek to minimize portfolio variance for their clients by recommending that they invest in a diversified portfolio which includes both large and small market capitalization domestic stocks, as well as bonds, international equities and real estate. |
